Looking at investing in REIT ETFs? Take your time and watch your weight

Can you elaborate on why you selected the market-weighted iShares S&P/TSX Capped REIT Index Fund (XRE) for your Strategy Lab dividend portfolio, rather than the BMO Equal Weight REITs Index ETF (ZRE)? I'd read that the market weighting gives too much emphasis to RioCan REIT, and when I did a comparative chart it seemed that the BMO ETF has had better results lately. I bought XRE recently, and maybe if we weren't down $200 already, I might not be asking.

Hmmm. Do I detect a little buyer's remorse?

If it makes you feel any better, I've noticed a trend with my own investments: Whenever I buy something, it immediately goes down. At least it seems that way.

Before I get into the differences between XRE and ZRE, it's worth remembering that focusing on short-term price movements is a sure way to drive yourself nuts. It can even lead you to do things you might later regret, such as selling out of fear.

The fact that your investment is down by $200 shouldn't matter if you are planning to hold it for many years. Real estate investment trusts (REITs) are equities, after all, and they will bounce around in price. So you had better get used to it.

If such volatility makes you uneasy, you might consider setting up a simple spreadsheet or hand-drawn table that lists all of your holdings and the annual income from each of them. If you focus on your income - which should steadily grow over time - it will make it easier to deal with market volatility.

Now to your question about XRE and ZRE.

As you correctly point out, XRE is a market-weighted exchange-traded fund (ETF), which means bigger companies (based on market capitalization) account for a larger share of the fund's assets. RioCan's weighting in XRE is currently about 21 per cent, more than 10 times the weighting of XRE's smallest constituent, Crombie REIT.

Is that a bad thing? It depends. If RioCan hits a rough patch, XRE will certainly suffer. On the other hand, if RioCan does well, the fund will benefit. Also keep in mind that RioCan operates more than 300 shopping centres and is the largest REIT in Canada. Its expansive real estate portfolio provides plenty of diversification all by itself, so the heavy index weighting may not be as much of a problem as it first appears.

BMO's Equal Weight REITs Index ETF (ZRE) takes a different approach. As the name implies, the constituents are weighted roughly equally regardless of their size. RioCan and Crombie, for example, are both currently weighted between 5 per cent and 6 per cent.

BMO argues that equal weighting is a superior strategy because it reduces the risk of any one company having a negative impact on the fund. The strategy also boosts the overall yield of the fund, because smaller companies with relatively high yields get the same weight as larger companies that may have smaller yields.

Critics would argue, however, that equal weighting gives too much influence to smaller, less liquid names.

Why did I "buy" XRE for my Strategy Lab model portfolio? I didn't actually perform a lot of rigorous comparative analysis; I have owned XRE for years personally, and I was comfortable with RioCan as a company so the weighting didn't bother me. That said, I can also see the merits of ZRE's equal-weighting strategy, and I would consider purchasing ZRE if I wanted to add to my REIT exposure (I like to keep REITs to about 10 per cent of my total assets).

You mentioned that ZRE has outperformed XRE recently. That's true. ZRE's year-to-date return, including reinvested distributions, is 16.9 per cent, according to Bloomberg. That beats XRE's year-to-date return of 13.7 per cent.

But if you look at ZRE's performance since its inception on May 26, 2010, it's up 57.7 per cent, including dividends. That trails XRE's return of 64.5 per cent over the same period.

The question now is: which ETF will do better in the future? Nobody knows the answer. If you're worried about putting your money "on the wrong horse," you might consider splitting your REIT allocation equally between ZRE and XRE. That way, no matter which ETF comes out ahead, you'll own it. And you'll be less likely to suffer from buyer's remorse.